Hih Royal Commission: Auditors Independence

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Table of Contents

Executive Summary
Introduction
Discussion
Conclusion
List of References

Executive Summary

Independence of auditors has been criticized vehemently during post HIH, Enron and other scandals. Various legislative reforms to bring back the sanctity of independence were introduced in different countries like CLERP 9 in Australia and Sarbanes Oxley Act in U.S. Before introduction of amendments and changes in the corporation legislation in 2004, recommendations of CLERP 9 were reviewed and analyzed under different studies and the important among those was the analysis and recommendations of HIH Royal commission report.

In this write up, the independence of auditors have been viewed in wake of the recommendations of HIH Royal commission report as considered under CLERP 9 act that become effective from 1 July 2004. It would be revealed in this essay that in order to ensure the independence of auditors most of suggestions and recommendations of HIH royal commission report have been incorporated in the corporation legislation via CLERP 9.

Introduction

Independence of auditors during the conduct of audit is an auditor’s privilege to maintain the sanctity of auditing conduct. It is true that auditors’ image suffered a set back during the recent scandals, but efforts like introduction of CLERP 9 in Australia and SOX in US and other legislations in other countries is an effort to bring back the auditors’ privilege of independence. The amendments under CLERP 9 act mostly resemble recommendations made by HIH Royal commission that has been critically discussed here in this essay especially with references to legislative changes and additions brought in by CLERP 9 from the point of view of maintaining independence of auditor. It is argued that “the passage of CLERP 9 through parliament is a major step forward in corporate governance that will improve the transparency and efficiency of Australian business.”(Ross Cameron, 2004)¹

Discussion

The Company Law Economic Reform Program (Audit Repot and Corporate Disclosure) Act, 2004 (CLERP 9) became effective from 1 July, 2004. The changes that have been effected vide CLERP Act, particularly relating to independence of auditors fall into the categories of

general auditor independence requirements,
specific auditor independence requirements,
restrictions on auditors being employed by an audit client,
auditor rotation for listed companies.

When businesses do well, auditors need not worry about their reputation; but when business fair unexpectedly the auditors are expected to reason out the causes of failures through the independent conduct of audit. In order to do this onerous job, the auditor must possess certain qualities and one of those qualities is that statutory auditor must act independent of client during the performance of auditing duties. “Professional independence is a concept fundamental to the accountancy profession.

It is essentially an attitude of mind characterized by integrity and objective approach to professional work.”(Kamla- Raj, 2005)² Though statutory auditors are appointed by the shareholders but it is seen as per past experiences that they work under the pressure of directors or senior management of the company and produce reports that does not offend the wishes of management.

The statutory independence requirements of auditors before the introduction of CLERP 9 in 2004 were rather very straight forward. The conditions or requirements for the appointment of auditor of a company were that auditor should not have been an officer of the company; and auditor or any company in which auditor had substantial interest should not have owed $5000 or more to the company in which the appointment was being considered. As per the provisions of Ramsay report these previsions were not adequate to maintain the independent stature of the auditors. Based on the recommendations of Ramsay report and the findings of HIH Royal Commission, CLERP 9 reforms were introduced casting a net on independence of auditors more widely and extensively.

The HIH Royal commission report identified a number of breaches that caused the failure of HIH Insurance Group and one of those were those provisions of Corporation Act that affected the independence of auditors. Observing the importance of independence of auditors in different concerned and connected financial fields, “Mr. Justice Owen emphasized the importance of audit function and capital market as whole and the reliance placed on the audit function by users of financial statements. In finding this, he thought that the CLERP 9 standard, which requires that a reasonable person, informed of all relevant circumstances, would conclude that auditor is not independent, was too high.

Rather, the standard should be stated in terms that auditor would not be independent if a reasonable person might conclude that the auditor’s independence might be impaired.” (Richard Alcock and Carl Bicego May 2003)³ The HIH report also desired that it should be clarified that independence criteria needed to be applied to both individual auditors as well as to audit firm undertaking the audit assignment.

The HIH Royal Commission report also pointed out the resultant effect of non- audit services on the independence of auditor. In this regard it was suggested that auditor should be required to make a self review of the effect of other non- audit services on auditor’s independence. This was highly important suggestion because of involvement of direct pecuniary benefits while performing non- audit services.

When auditing is conducting by same auditor who is also rendering some other non- audit services to the same audit client, then, frankly speaking, some portion of auditor’s independence would be in danger of getting impaired, unless the auditor conducts a self check on the conduct of his auditing functions. This is what HIH Royal commission report intended when making a suggestion of self review by the auditor providing non- audit services as well.

Taking account of such a danger on the independence of auditor when other non audit services are also being rendered, the recommendations of CLERP 9 included two actions. First, fee paid to auditors for audit and non- audit services be mandatory disclosed in annual report; and secondly the audit committee should provide a statement in annual report that the committee was satisfied with independence of auditor during the conduct of audit keeping in view other non- audit services being provided by the same auditor. It is important to note that HIH Royal commission report never recommended the prohibition of such non- audit services being rendered by the same auditor.

The services that could affect the independence of auditors as stated in the HIH Royal commission report included the services of keeping accounts and preparation of financial statements, valuation services, internal auditing, assignment of temporary staff with audit client, legal services, services that support some ongoing or other litigations, providing or making arrangement for the provisions of senior management staff, and above all the arrangement of finances for the audit client.

Another matter that was discussed in great depth of HIH report was the employment associations of auditors with the audited company. According to HIH report such associations create a sort of familiarity threat to the conduct of audit and thus destroy the independence of the auditors. The view at that time in HIH report was that discussion paper of CLERP 9 was insufficient, and the report made following recommendation which were not fully taken care of while introducing the necessary amendments in the Corporation Act:

Senior staff of audit firm should be rotated at least after five years. The recommendations of CLERP 9 discussion paper related only to junior staff.
HIH report suggested that recommended waiting period of 2 years by CLERP 9 discussion paper needed to be extended to 4 years for the purpose of auditing staff to join the board of audited company. Further 2 years waiting period should also be made applicable to partners of audit firm who did not participated in conducting the audit
It was suggested that not more than one of the total partners be appointed on the board or senior management of the audited company by following above waiting period.

The HIH report also recommended that the language of audit report should be plain English. It is presumed that such a suggestion was required because the financial statement users are scattered over all concerned sections of the society speaking different languages, and English is common international language.. Moreover the report also suggested that audit report should also include a review on operations and financial activities of the company. On this issue critics felt that this is like asking for extra and further explanations in audit report from the auditors, as already the report contains the provisions to make necessary qualifications on financial statements; and certainly this can only be based on such a review conducted by the auditors.

As already stated above that the Corporation Act amendments, based on CLERP 9 reforms, have specified both general and specific requirements to safeguard the independent status of the auditors.

The focus of general requirement is to avoid the situation of ‘conflict of interests situation’. These requirements, set out in ss. 324CA-CC are applicable to individual auditors, to each and every member of audit firm and to all directors of audit corporation. A ‘conflict of interest situation’ implies the existence of a situation where under the auditor is not in a position to exercise an impartial and objective judgment during the conduct of audit, or at least reasonably it can be concluded that the situation so exists for the auditor to conduct audit deliberations objectively and impartially.

This situation may occur due to auditor’s relationships with the company or its directors or with management of the company. If auditor has knowledge of such a ‘conflict of interest situation’ then he has to inform ASIC about this within a period of seven days, otherwise the auditor would be committing an offence under the act by accepting or conducting the audit knowingly the existence of ‘conflict of interest’ situation. The interesting part of the newly included legislation is that auditor would also be committing an offence even if he had no knowledge about the existence of ‘conflict of interest situation’ unless the auditors have in place a quality control system to analyze and make auditor aware such a situation.

Then there are very specific requirements of the law to check the independence of the auditors. The specific requirements are related to relationships of the auditors and others connected with auditors with the company to be audited or being audited. The relationship list is very exhaustive and basically covers the role relationships, property relationships, and financial relationships. The role relationships cover such relationships where the auditor was an employee of the audited company.

The property relationships cover such instances where auditor has an asset that can be considered as an investment in the audited company. Finally, the financial relationships are the relationships where the auditor owes money to or the money is owed by the audited company. This exhaustive list covers around nineteen such relationships between auditor and the person associated with audit and the audited company.

The persons associated with audit include persons with whom different roles of property and financial relationships apply. The covered associated persons are family members of audit team members and also of the non audit services suppliers to the audited company. Furthermore, s. 307C casts a responsibility on the auditor to provide information to the directors of the company about any contravention about the independence requirements of the auditors. These provisions act as detrimental force to pursue any auditing activity that contravene the newly introduced and existing legal provisions safeguarding the independence of auditors.

Further there are very distinct efforts to maintain and improve the independence of auditors. “It is not enough merely to impose new requirements on auditors. Companies must bear some responsibilities for ensuring their external auditors bring an independent mind to the task of auditing financial reports.”(Senator Chapman, 15 June 2004)⁴

Conclusion

‘CLERP 9 is considered to be an answer to the HIH debacle and development overseas.’ (Kehl, 2002)⁵ CLERP 9 is revolutionary in its approach, but the success of any legislation is dependent on its implementation. In others words, these are companies and auditors themselves who are really capable of bringing back the lost reputations of auditors by adhering to the provisions of CLERP 9. That is the only way to restore the independence of auditors and the lost faith in the pronunciations of audit reports.

List of References

Ross Cameron, Passage of CLERP 9 Signals New Era in Corporate Governance, Treasury Portfolio Ministers, No. 023. Web.
Pade Adrebigbe, Auditor’s Independence and Corporate Fraud. 2008. Web.
Richard Alcock and Carl Bicego, The HIH Report and CLERP 9, Find Australia Law, 2003. Web.
Senator Chapman, Comments while releasing the two part report CLERP 9 Bill 2003. Media Release Parliamentary Joint Committee on Corporations And Financial Services. Web.
Kehl, CLERP 9, 123 School Work. 2008. Web.

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